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Articles | A Choice of Tax Treatments for TSP Participants
A Choice of Tax Treatments for TSP Participants
The Thrift Savings Plan (TSP) offers you two tax treatments for your employee
contributions when you make a contribution election:
1. Traditional TSP -- If you make traditional contributions,
you defer paying taxes on your contributions and their earnings until you
withdraw them. If you are a uniformed services member making tax-exempt
contributions, your contributions will be tax-free; only your earnings will be
subject to tax at withdrawal.
2. Roth TSP -- If you make Roth contributions, you pay taxes
on your contributions as you are making them (unless you are making tax-exempt
contributions from combat pay) and get your earnings tax-free at withdrawal, as
long as you meet the requirements to qualify.
Traditional TSP and Roth TSP
The Thrift Savings Plan began accepting Roth TSP employee contributions in
May 2012. All employee contributions made before May 2012 are considered
traitional contributions. When a participant is automatically enrolled in the
TSP, he or she begins by making traditional contributions. If you want to make
Roth contributions, you have to submit a contribution election to tell your
agency what portion of your contributions you want designated as Roth.
*If you are a member of the uniformed services receiving tax-exempt pay (i.e., pay that is subject to the combat zone tax exclu- sion), your contributions from that pay will also be tax-exempt.
Traditional (pre-tax) contributions are taken out of your paycheck before
your income is taxed. This lowers your current taxable income and gives you a
tax break today. If you are a FERS employee, your agency's contributions also
go into your traditional balance. This money grows in your account tax-deferred,
but when you withdraw your money, you pay taxes on both the contributions and
Roth (after-tax) contributions are taken out of your paycheck after your
income is taxed. When you with¬draw funds from your Roth balance, you will
receive your Roth contributions tax-free, since you already paid taxes on these
contributions. In addition, you will not have to pay taxes on the earnings, as
long as 5 years have passed since January 1 of the calendar year when you made
your first Roth TSP contribution (known as the 5-year rule) AND you are at least
age 59 1/2, permanently disabled (or deceased). If you satisfy these Internal
Revenue Code (IRC) requirements, your earnings will be considered "qualified,"
and you will not pay any taxes on them at withdrawal.
Note: The TSP cannot certify to the IRS that you meet the IRC's definition of
disability when your taxes are reported. You must provide the justification to
the IRS when you file your taxes.
Tax-exempt contributions are contributions uni-formed service members may
make while earning tax-exempt pay in a combat zone. If your tax-exempt
contributions are designated as traditional contributions, you will pay no tax
on the contributions, but your earnings will be taxed when withdrawn. If your
contributions are designated as Roth, you will pay no taxes on your
contributions, and their earnings will also be tax-free when withdrawn, as long
as you meet the IRC requirements detailed in "Roth (after-tax) contributions"
on this page.
Traditional and Roth balances. If you make an election to choose Roth
contributions, your account will then be made up of two separate
balances--traditional and Roth. These two "pots" of money will keep your
contributions and any money you transfer into (or out of) your TSP account
separate for tax purposes, but any loans, withdrawals, and interfund transfers
you make will include a proportional amount from each balance. You will not be
able to take out, borrow from, or change the investment of, just one pot of
Traditional Contributions vs. Roth Contributions:
An Example of the Effect on Your Current Income
When you make traditional pre-tax contributions, you get two immediate tax
advantages: Your actual TSP contribution is not taxed (it's tax-deferred until
you withdraw) AND the money you contribute is taken out of your pay before
Federal (and in most cases state) income taxes are calculated. As a result, the
amount of pay used to calculate your taxes is reduced, so less money is
with¬held from your pay for taxes.
When you make Roth contributions, assuming you con¬tribute the same
percentage or amount of your pay to the TSP as you contribute in traditional
contributions, more money will come out of your annual take-home pay.
Based on a participant filing singly -- with one personal exemption and standard deductions.
The difference: If you made traditional pre-tax contributions, you
would have $308 more in your pocket in the current year than if you made Roth
Traditional Contributions vs. Roth Contributions:
An Example of the Effect on Your Long-Term Savings
Choosing between traditional and Roth contributions comes down to whether
you would be better off paying taxes on your contributions now or later; in
other words, your marginal tax rate now versus your rate at retirement. Your
personal situation will determine whether it is better to have the tax savings
of traditional contributions now or the tax-free earnings of Roth contributions
To demonstrate this tax principle, suppose in one year you could afford to
give up $4,000 of your income for retirement savings in the TSP, and you are in
the 25% tax bracket. You could put $4,000 (traditional pre-tax), or $3,000 (Roth
after-tax) into your TSP account. (The $4,000 that comes out of your paycheck to
make Roth contributions = $3,000 in contributions + $1,000 in Federal income
taxes.) The chart below compares the value after 10 years (at 6% annual rate of
return) of this one-year $4,000 paycheck deduction after taxes, taking into
consideration a lesser, equal, or greater marginal tax rate at retirement.
Generally, traditional contributions are to your advantage if your tax rate
will be lower in retirement. Roth contributions are to your advantage if your
tax rate will be higher in retirement. If your income tax rate is the same in
retire¬ment as when you made the contributions, you'll end up with the same
amount in your account whether you make Roth or traditional contributions.
The Contribution Decision Wizard on the TSP website (https://www.tsp.gov/planningtools/contributioncomparison/contributioncomparison.shtml)
allows you to input information about your own situation and compare the
effects of making traditional and Roth contributions on your long-term savings
(as well as your paycheck). Visit the Contribution Decision Wizard to see
whether making Roth contributions could be to your advantage. You should also
consult a qualified tax advisor or financial advisor. Remember to reassess your
decision any time your tax, income, or personal situation changes.
When you withdraw your money from the TSP, you will owe taxes on any
traditional contributions (except contributions made from tax-exempt pay), and
the earn¬ings they have accrued. You can continue to defer these taxes by
transferring or rolling over your TSP withdrawal payment to a traditional
individual retirement account (IRA) or an eligible employer plan. You can also
transfer or roll over your traditional funds to a Roth IRA, but you will have to
pay taxes on the full amount in the year of the transfer.
If you have Roth contributions in your account, you have already paid taxes
on them. You will not owe any further taxes on your Roth contributions, and you
will not owe taxes on their earnings if your withdrawal pay¬ment is a "qualified
distribution." In other words, if 5 years have passed since January 1 of the
calendar year when you made your first Roth contribution and you have reached
age 59 1/2, or have a permanent disability, the entire Roth portion of your
account will be paid out tax-free. If your earnings are not qualified, you can
defer paying taxes on them by transferring your payment to a Roth IRA or Roth
account maintained by an eligible employer plan.
Retirement age and the penalty tax. If you receive a TSP withdrawal payment
before you reach age 591/2, you may have to pay a 10% early withdrawal penalty
tax on any taxable part of the distribution not transferred or rolled over. This
penalty tax is in addition to the regular income tax you owe, but there are
exceptions. In general, if you leave Federal service in the year you turn age 55
or older, the 10% penalty tax does not apply to any withdrawal you make that
year or later.
In addition, disability retirement approved by the Office of Personnel
Management may not exempt you from the early withdrawal penalty tax. The IRS
requirement is more stringent, and you will have to substantiate your claim of
exemption with the IRS. There are other exceptions to the early withdrawal
penalty tax. See the tax notice "Important Tax Information About Payments From
Your TSP Account," which is available from the TSP website, your agency or
service, or the TSP. The tax rules that apply to distributions from the TSP are
complex, and you may also want to consult with a tax advisor or the IRS before
you make any withdrawal decisions.
Retirement Savings Contributions Credit. You may be able to take a tax credit
of up to $1,000 (up to $2,000 if filing jointly) for your TSP contributions.
Eligibility depends on the amount of your modified adjusted gross income (AGI).
For tax year 2012, your AGI must be no more than $57,500 if married filing
jointly, $43,125 if head of household, or $28,750 if single, married filing
separately, or qualifying widow(er). (These amounts are adjusted each year for
inflation. For more information, see your tax advisor or refer to IRS Form
Source: TSP [TSPBK08 (5/2012)]